Asset allocation decides equity and debt fund picks
Choosing between equity and debt funds is about looking at your risk tolerance, what you want to do with your money and your existing portfolio
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Many readers ask if they should, at a given point in time, invest in equity or debt mutual fund schemes. So whether it is monetary policy time when, for instance, interest rates are either expected to fall or have already fallen, or when equity markets are rising, many investors tend to look for the next big opportunity. But choosing between equity and debt funds is not a matter of which option gives a higher return. It’s about looking at your risk tolerance, what you want to do with your money and your existing portfolio.
Don’t blindly put away your money in any financial instrument. Ask yourself why you need this money and then assess when you will need it. If you think you won’t need the money within 3-5 years, then it is better to put money away in an equity fund, even if, say, debt funds have been doing well. Even if interest rates are falling (inverse relationship between interest rates and debt fund security prices at play here—when interest rates fall, debt securities’ prices rise and vice versa), you shouldn’t blindly put your money in a debt fund. If you think you would need the money many years from now, it’s better to put it in an equity fund, because over the long run, chances of equities outperforming debt instruments are higher. For shorter-term needs, go with debt funds even if equity funds are showing higher returns.
You should also not put away all your money in just equity or debt funds. We cannot stress enough on the importance of maintaining your asset allocation. In simple words, you should not have all your money in one basket. You need to have a healthy balance between equity and debt.
How much of your money should lie in equity and how much in debt, will depend on how much risk you can tolerate and your financial goals.
If you have money to invest, try and see the existing tilt of your portfolio and invest accordingly.
Just because a certain equity or debt fund has done well so far, doesn’t mean you should run to put your money in it. Past performance doesn’t guarantee future returns, though it gives an indication. But assess if your risk profile is suited for the fund you wish to chase. Past returns may have been high because the fund was inherently risky and its strategy paid off. For example, debt funds that take credit opportunities. Try to analyse if this strategy will work in the future as well.